Case of the Week

Lucky Lucy Lindstrom's Unitrust

Case:

Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucky Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucky Lucy was so successful in these markets that she now manages only her mega-dollar personal portfolio.

Somewhat late in life, Lucky discovered the wonderful world of philanthropy. She volunteered at her favorite charity, and has learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market. After reading about a charitable remainder trust in the charity's weekly eNewsletter, Lucy called Clara Johnson, the gift planner for her favorite charity. Lucy suggested that she would transfer $5,000,000 of securities to a 5% net plus makeup unitrust. She would serve as trustee, make the investments and her favorite charity would be the remainder recipient. Since Lucky Lucy normally earns 14% per year on her futures and commodities investments, she feels that it would be easy to make the unitrust grow to $10,000,000 or more.

Question:

Would this plan work? May Lucy serve as trustee? Is it permissible to invest unitrust assets in the futures market?

Solution:

With a possible $10,000,000 gift from the unitrust, gift planner Clara Johnson very much wants to make this plan work. However, there are several potential obstacles. First, it is permissible for Lucky Lucy to serve as trustee. The trust document can include provisions to appoint an independent special trustee to handle hard-to-value assets or for other needed purposes. Lucy's favorite charity or a corporate trustee could be successor trustee. Second, a trust administration company can be hired to do the accounting and unitrust tax returns. This service is available for a reasonable 20 to 40 basis points per year.

The key issue is the unitrust investments. Unitrusts are generally subject to Sec. 4944 rules on investments that may jeopardize the charitable remainder. Section 4944 imposes a tax on investments that jeopardize the carrying out of any of the exempt purposes of a private foundation. Section 53.4944-1(a)(2)(i) states that an investment shall be considered jeopardizing if the foundation managers have failed to exercise ordinary business care and prudence under the facts and circumstances prevailing at the time the investment is made. While no category of investments shall be treated as a per se violation, certain types of investments (such as investments in futures, options, puts and calls) require close scrutiny to determine whether the foundation managers have met the requisite standard of care and prudence.

However, in PLR 200218038, the Service permitted a private foundation to use four brokers to invest in futures and commodities (note that a PLR is not a legal tax precedent). The plan by Lucky Lucy is clearly somewhat aggressive. But if she is willing to use methods for her futures and commodities investments that reduce risk to the "ordinary business care and prudence" standard, then her plan may be acceptable.

A better solution is to use a combined investment strategy. Lucy will be investing both the unitrust assets and her personal portfolio. Since she knows that some investments are more risky than others, she uses her personal assets for most of the risky investments and her unitrust is invested in less risky securities.

Lucy used that method very successfully. Her unitrust, with "conservative" futures and commodities investments, averaged a 12% return, while her personal portfolio produced a greater return with greater risk and volatility. Lucy considers herself "Lucky" because she now has a substantial personal portfolio, a large unitrust and a warm feeling from helping others.